The housing market has cooled off in recent months, but an interesting phenomenon happened during the housing boom as home prices soared beyond the means of many home buyers. They kept buying.
How? Often with the help of "alternative mortgage products." The so-called AMPs include adjustable-rate mortgages that leave borrowers vulnerable to interest rate hikes, as well as interest-only loans in which borrowers defer payment on the principal. Real estate industry data suggest that such "exotic" loans were just 2 percent of loans in 2000 but now represent as much as one-third of loan agreements.
The Federal Deposit Insurance Corp. reported that the riskier loans have been both a cause of and a reaction to the housing boom and, not surprisingly, are continuing and are more common in areas that have had the steepest price increases. That would include Las Vegas, where housing prices have leveled off a bit, but where the cost for a new or an existing home today still outstrips what people with average incomes can afford.
All of this has Congress and consumer advocates worried. The exotic loans enable borrowers to buy homes they normally couldn't afford by shrinking their initial monthly payments, sometimes with initial "teaser" interest rates at 1 or 2 percent. But eventually buyers face huge payments as lenders seek to recoup the principal - plus the interest that went unpaid in initial payments. That unpaid interest is added to the principal, which effectively lessens the buyer's equity.
In some cases monthly payments could double or triple, Sandra Thompson, FDIC's acting director of supervision and consumer protection, told the Senate Banking Committee this week. That could leave borrowers in serious "payment shock," experts say. Ultimately, loan defaults, foreclosures and the shattered dreams of families may follow.
Experts say it's too early to tell how many of the exotic loan deals could end in borrower ruin. But much is at stake - the nation's entire economy is at "significant risk" if great numbers of the loans fail, Michael Calhoun, president of the watchdog group Center for Responsible Lending, told the Senate panel.
Why are so many borrowers willing to risk so much? Part of the problem is that they don't understand the complex loan agreements.
That was one finding of Congress' Government Accountability Office, which released a report this week that said lenders often emphasize loan benefits over the high risks. The GAO reported that loan agreements often are poorly written or cast in highly complicated terms at reading levels higher than those of most U.S. adults. And key loan disclosures often are buried in the fine print - in type sizes and fonts that are too small and difficult to read, the GAO said.
Federal regulators should lean on lenders to be more responsible. The GAO recommended that the Federal Reserve Board review its loan disclosure standards to improve mortgage agreement clarity. That's a good start.
Meanwhile, lenders should not loan money to people who can't afford the debt load. Lenders also should simplify their loan agreements and invest far more time explaining them to borrowers.
Finally, buyers should seriously consider the risks of alternative loans and read their contracts carefully. They bear the ultimate responsibility for accepting more debt than they can handle.
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